Small savings schemes rates — Time for a rate cut to boost real estate?

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The real estate sector has witnessed subdued demand over the last several years. With liquidity conditions tightening, a general economic slowdown, oversupply of fresh units, and piling up of inventories, the sector has seen its fair share of challenges.

However, with the historic low-interest rates and stamp duty cuts last year, we saw some movement in real estate assets which suggested that the worst for the sector might be over. Real estate is an interesting purchase as while many (including myself) would argue that it is a consumption item — there are many who view real estate as an asset. Indeed, it is an asset, that does grant returns in the form of capital gains or rents — but the question is whether its returns are the highest for the risk profile when compared to other investment options with a similar risk profile.

Realty check

Most households in India would wish to have their own residential property, rather than living in a rented house. Therefore, owning a home is a key aspiration for a majority of Indian households. A key cost of owning a home comes in the form of interest rates on residential mortgages. The rate of interest has indeed moderated over the last several quarters, however, there is still scope for bringing them down further.

Also Read: Further cut in small saving scheme interest rates will hurt the ordinary saver

In order to bring them down, what is needed is a moderation in the small savings rates which would reduce the cost of deposits for banks thereby enabling them to further reduce mortgage rates. Doing so is beneficial as it will further reduce the monthly costs associated with owning a home and help push demand for real estate assets across the country. The government had announced a similar cut in March 2021; however, it was reversed due to backlash from various interest groups, including savers.

Inflation math

Many believe that a lower small savings rate would have an adverse impact on their capital accumulation process. Thus, those with adequate savings, including pensioners and senior citizens, would want the rates to be higher rather than lower. However, economics is concerned with real variables. That is, people with savings are interested in the real value of their money — the number of goods and services that it can purchase in the future. Therefore, we need to view any interest rates with prevailing inflation rates in the economy. At present, several small savings rates are close to 7%. The recent inflation figures were inching back to the 4% level, thereby indicating that the inflationary impulse experienced last year was more because of supply disruptions. With inflation on an average at 4%, a 7% savings deposit interest rates mean a real rate of 3%, which is significantly high. Most emerging markets have their rates between -0.5 to 1% range.

Even historically, we have had – 2, – 3 real rates in the past, which meant that savings were being eroded due to inflation. That no longer seems to be the case. The issue of small savings rates is an important one as it pertains to not just the interest of savers, but also to the prospects of boosting economic activity and reviving the demand for housing in the country.

It is therefore important that we recognise the scope for further reduction in small savings rates which would help get economic activity back on track. A major reform in this regard should be to link these rates with the repo rates. That will ensure that our small savings rate move with RBI determined repo rates, which are determined by the Monetary Policy Committee after considering the inflation rate and future inflation expectations. This will ensure that our senior citizens and their savings will continue to be protected from inflation, even as we push the rates lower to give a much-needed boost to our economy.

There may be a lot of opposition and push back on small savings cuts, however these cuts are in the interest of the economy, and India’s middle class. The economic boom in early 2000s could have been an outcome of a similar such cut – and it will be no different in 2021.

(The writer is an economist and policy-researcher. Views expressed are personal)